The S&P 500 Took a Tumble but Here’s Why the Santa Rally Isn’t Called Off

The Dow tumbled 475 points in the previous session and the
S&P 500
plunged 1.5%, a neck-turning reversal on the back of seven straight weeks of gains for both indexes. “There wasn’t an obvious catalyst that was responsible,” said Henry Allen, an analyst at Deutsche Bank. “Maintaining that momentum was always likely to prove difficult.”

Analysts point to a multitude of possible factors for the midweek declines. “Equites may have corrected lower due to profit-taking or large purchases of put options for hedging purposes as portfolio and fund managers begin their Christmas holidays,” said Charalampos Pissouros, an analyst at broker XM. In the derivatives market, put options refer to wagers that prices will fall, and can be used to hedge other, more bullish, bets.

But there is little reason to believe that the strong stretch for stocks has been undermined. Indeed, the two-month market rally has come amid expectations that waning inflation and slowing growth will push the Federal Reserve to cut interest rates multiple times next year—and that narrative has, ultimately, not been disrupted.

Investors continue to brace for a spate of rate cuts that could start early in 2024, with traders assigning 70% odds that the Fed will begin lowering borrowing costs from their generational peak as soon as March, according to the CME FedWatch Tool. As long as economic data remains supportive—and, duly noted, a key inflation is due Friday that could disrupt sentiment—rate cut bets should hold firm and support stocks. 

“The market seems overstretched and may correct even lower, but should investors remain convinced that the Fed will cut rates massively next year, they could also remain willing to add to their risk exposure again soon,” said Pissouros.

With investors gearing up for the holidays, a Santa Claus Rally—the tendency for markets to rally through year-end—is still a festive prospect.

Write to Jack Denton at jack.denton@barrons.com